William Pentland, Contributor
I write about energy and environmental issues.
Last Friday, House of Representatives Republicans released a little-noticed report outlining their priorities on future climate change and energy policy.
“An energy policy that does not address all facets of energy production is a failure and threatens our economy, our national security and the environment,” Reps. Tom Davis, R-Va., and Darrell Issa, R-Calif., said in a press release announcing the release of the report. They might as well have written a ransom note.
Obama’s plans to finance an ambitious clean energy agenda by imposing a de facto carbon-emissions tax in the form of an auction-based cap-and-trade system has set the stage for an epic showdown on Capitol Hill over carbon emissions and energy legislation. The outcome will likely shape energy and environmental policies for decades.
But it also has the potential to derail the new president’s larger agenda, as campaign promises, fiscal realities and industry pressure collide–a scenario that swamped the early days of the Clinton administration’s work on health care. “If Obama wins the election,” a report by Stanford Financial Group predicted in August, “he will face pressure to be very aggressive on strict limits and auctions and could find himself in the unenviable position of having his climate change effort become his ‘Hillary Care.’ “
Under a cap-and-trade system, a regulatory body allocates CO2 emission allowances to companies, typically by way of auction, but sometimes for no cost. Each allowance represents the right to emit one ton of CO2 or CO2-equivalent GHG. The total allowances distributed to a company represent the total emissions that it can produce in any given year without penalty. Companies that emit less than their allowances permit, or can reduce emissions more cheaply than their peers, can either bank their surplus allowances for future years or can sell them to companies whose emissions exceed their own allowances.
In Europe’s cap-and-trade scheme, the European Union allocated emissions allowances for free to emitters of carbon dioxide or other greenhouse gases. The bulk of the value of these grants has accrued to the owners of the emitting facilities, according to multiple analyses. In particular, European power generators factored the secondary market value of their allowance grants into their production costs–leading to significant increases in European power prices and profits.
If the U.S. also allocates allowances for free, unregulated power, generators will likely pass through the value of allowances consumed to wholesale power prices. In other words, cap and trade would be a boon for carbon-intensive electricity producers–at least those located in unregulated electricity markets–because they raise rates to reflect the market value of those allowances.
“Regulated utilities will reposition their cash outlays so that they will recover their costs by raising rates,” said Hugh Wynne, a senior research analyst at Sanford C. Bernstein. “Unregulated utilities will pass through the costs by raising the prices they charge in wholesale markets.”
While Obama and McCain both supported cap-and-trade legislation, they proposed two very different systems. Obama’s version would make electricity producers buy emissions allowances, and McCain’s version would have given them allowances free. These systems may lead to similar carbon emissions cuts, but they also lead to wildly different economic outcomes.
It doesnt matter whether emissions allowances are auctioned or given away freely,” said Michael Wara, an assistant professor of law at Stanford Law School. “Both approaches ultimately have the same impact on cutting carbon emissions. Generally speaking, they also have the same impact on the broader economy. The only difference is who ends up with the money. Were creating a huge asset class and different constituencies have different claims to it. Who gets the goodies? This question will drive the politics far more than the size of emissions cuts. Only legislation that answers this question in a way to the satisfaction of the stakeholders has any real chance of passing.
McCain’s system would have given unregulated power generators a windfall profit. Although power generators would receive allowances with no offsetting cost, unregulated generators could still demand higher prices because of those allowances, which would increase profits materially. In particular,
On the other hand, an auction-based cap-and-trade system would require power generators to buy allowances from the government. This would drive up electricity prices for consumers, especially in coal-fired regions like the Midwest and Southeast. Meanwhile, an auction-based approach would be a boom to renewable energy projects like wind, solar and geothermal, which would not need to buy carbon allowances.
“If coal-fired plants and natural gas plants are selling electricity in the same market, coal producers will have to buy twice the number of allowances as natural gas plants,” said Wynne. “It may not put them out of business, but it will squeeze their margins and reduce their profitability.”
Obama campaigned on a platform that championed an exclusively auction-based cap-and-trade system. While campaign promises seldom translate perfectly into post-election agendas, this particular campaign promise could seem especially less palatable now. If producers had to pay $25 for every metric ton of carbon they emitted, rates would need to rise anywhere from 23% to 43% at coal-fired utilities in the Midwest and 15% to 29% at coal-fired utilities in the Southeast to offset the costs of emissions allowances, according to a recent analysis by Bernstein Research.
In different circumstances, Obama could ease the hike in electricity prices in particularly sensitive areas like Appalachia, which has a higher concentration of low-income households and coal fired plants than other regions, by mixing auctions and allowances as needed. But doing so could undercut an equally important campaign promise to ramp up spending on energy research and development, especially since the Wall Street bailout depleted government coffers, and a slowing economy reduced tax revenues.
The result: The Republican minority in Congress has ample fodder to fight the full implementation of Obama’s clean energy and carbon emissions cuts agenda. If Democrats push the agenda too aggressively, they risk provoking a political backlash. Welcome to the White House, Mr. President.